Trends—March 2011

Texas Holds ‘em, Amazon Folds

In 2005, Amazon.com announced plans to build a new distribution center in Irving, Texas, near the Dallas/Fort Worth International Airport. The city council cleared the way for the facility by approving an economic development incentive package that provided tax rebates to the company for six years, with options to extend the agreement another decade.

The arrangement wasn’t harmonious for long. In fact, Texas Comptroller Susan Combs and her office have been after the e-commerce company since 2008 to pay uncollected taxes on transactions in the state. The problem is that neither party can agree on what constitutes a physical distribution presence— and, therefore, whether Amazon is liable for payments past due, plus penalties and interest, from 2005 through 2009.

Amazon has run into problems with states and sales tax before. The company does all of its business through the U.S. Postal Service, with physical properties in Kansas, Kentucky, North Dakota, and Washington, according to Aaron Kelly, an attorney with Scottsdale, Ariz.-based The Kelly Law Firm. Amazon only pays sales taxes in these locations— as well as in New York, which passed a law in 2008 holding out-of-state sellers compliant.

The company believes it is compliant with state laws, and that its DCs, operating under a separate subsidiary, should not be required to pay sales taxes. Texas estimates that it loses $600 million each year from untaxed online sales— a figure that far eclipses what Amazon owes.

In September 2010, Texas asserted its position and asked Amazon to remit $269 million. Four months later, the e-tailer sued the state’s comptroller to release audit information regarding the payment. On Feb. 10, 2011, Amazon announced it was closing its Irving facility.

Responding to a request for comment, Mary Osako, a spokesperson for Amazon, shared an internal email that was communicated to employees:

“Because of the unfavorable regulatory climate created by the Texas Comptroller’s office, we are making the difficult decision to close our Dallas/Ft. Worth fulfillment center on April 12, 2011. Despite much hard work and the support of other Texas officials, we’ve been unable to come to a resolution with the Texas Comptroller’s office,” wrote Dave Clark, vice president, North American operations. “Closing this fulfillment center is clearly not our preferred outcome. We were previously planning to build additional facilities and expand in Texas, bringing more than 1,000 new jobs and tens of millions of investment dollars to the state, and we regret the need to reverse course.”

Business Magnet or Malaise?

Amazon isn’t the only party that regrets the recent turn of events. The state of Texas is losing one of its biggest economic development endorsements.

“We’ll work with lawmakers to make sure we can avoid this outcome in the future,” says Katherine Cesinger, press secretary for Texas Governor Rick Perry’s office. “The Governor hoped to see a different outcome. He’s not sure he would have made the same decision if he were in that position.

“That said, this is the purview of the Comptroller. If there is any uncertainty regarding the law in Texas, Governor Perry is committed to seeing that it changes to ensure we can strengthen the reliability of our tax system for employers who not only bring jobs to our state, but also help create wealth in our state,” she adds.

Cesinger’s comments are rife with political nuance, but the reaction from the Governor’s cabinet was visceral. There were hints, but Amazon’s swift decision came as a surprise.

Over the past few years, Governor Perry’s office has encouraged Amazon to expand its business in Texas. The state was aware of the company’s ongoing conversations with the Comptroller’s office. But clearly, no one was ever on the same page. And now, as consumer and business reactions saturate the media, opinions are scattering.

Small businesses are lambasting Amazon for not playing by the same rules that others have to abide by. For some, it’s a sad indictment of brick-and-mortar retailing, where customer service and brand affinity have been eclipsed by online buying selectivity and economy. Smaller companies now feel increasing pressure to shift online, and make their presence and profit via e-commerce channels.

Some blogosphere commentators have argued that where or how a sale is processed is irrelevant. Instead, the buyer’s state should serve as the taxing entity. Amazon is killing jobs, they say, because it doesn’t want to fulfill an obligation. States such as Texas would likely agree. But it’s easy to think and say one thing, then shop online and pay nothing— in terms of sales tax.

The current impasse raises other questions. If the state neglects going after businesses for unpaid revenue during an economic downturn— when education and other social services are being cut— wouldn’t the public also raise the alarm? And if Amazon files a lawsuit and feels confident in its case, why suddenly pack up and move? The company’s modus operandi is becoming increasingly familiar, and it has no qualms about absorbing the direct loss of closing a distribution center and the higher cost of in-state fulfillment from out of state.

Line in the Dust

Contrarians see Amazon’s posturing as a natural order of selection. The simple fact is that Texas consumers don’t walk into an Irving fulfillment center and place orders. There is a definitive line drawn in the dust between where products are purchased and where SKUs are accumulated and distributed.

Amazon’s business model is predicated on serving smaller businesses that leverage the company’s marketing and distribution clout to amplify their own sales operations. What began as an online book brokerage is now a multi-billion-dollar global consumer goods fulfillment conglomerate that empowers everything it touches— apart from Texas.

The bigger argument against the state is that competition for economic development investment will always favor business and consumers. If Texas isn’t willing to let sales taxes slide, another state will use abatements as a lure.

State governments are flummoxed by in-state business and sales that don’t deliver revenue or compete with homegrown companies that directly cater to consumers and pay sales tax. That’s certainly the case with Amazon and Texas.

“In addition to there not being any retail sales tax collected to benefit either the City of Irving or State of Texas, there is also very little ad valorem property tax on business personal property to the city,” says Jeff Mues, director of marketing and communications, Greater Irving-Las Colinas Chamber of Commerce. “The bulk of Amazon’s inventory qualifies for ‘freeport’ exemption. Most of all, in-state fulfillment centers in Texas qualify for the same benefit and pay very little business personal property tax on their inventory to their respective cities.”

The crux of the Amazon vs. Texas debate lies in defining “physical presence” and whether a DC or fulfillment center falls within these parameters.

Amazon’s Quill to Stand On

The crux of the problem lies in defining physical presence, and whether a DC or fulfillment center falls within these parameters. States such as Texas contend that any center where goods are stockpiled is a principal part of the order-processing cycle— regardless of where sales and orders are consummated.

Current legalese adds to the ambiguity. If a distribution center creates nexus— casual connection— it should be considered “physical presence.”

The Texas Comptroller’s office argues that federal law allows states to impose sales tax obligations on out-of-state retailers maintaining a “physical presence” in their state— defined as anything from a store, warehouse, or distribution center to a sales agent or delivery truck.

In the debate building around Amazon and Texas, legal observers cite the 1992 U.S. Supreme Court ruling Quill Corp. v. North Dakota. The state charged that Quill, an out-of-state mail-order office equipment retailer, should pay a use tax on merchandise used within the state— even though the company had no physical presence in North Dakota.

Quill’s only contact with the state came through mailing promotional catalogs to recipients in North Dakota, shipping orders via common carriers, and owning a few floppy disks in the state. The Supreme Court ruled eight to one in the company’s favor.

Kelly agrees that Quill Corp. v. North Dakota is the closest and most authoritative case comparable to Amazon’s predicament. But he believes we could be looking at a new legal ruling.

“That case only sets the test for when a state may tax a business— the courts will have to decide whether a business such as Amazon meets the test for taxation,” he says. “It’s likely that at some point an Amazon case, against Texas or another state, will be appealed by one of the parties all the way to the Supreme Court and set a precedent countrywide.”

All along, Amazon has contended that its Irving operation is a fulfillment facility, not a distribution warehouse— suggesting that inventory is moving, not static, and therefore part of the order cycle. It remains to be seen whether this position is defensible.

Clearing the Dust

The Texas and Amazon quarrel raises important issues that will likely linger. For the time being, the immediate question is whether there’s a common ground where states and e-commerce businesses can come to an agreement.

“The best thing that a state can do is to understand that more taxation on any business, whether it be in-state or out-of-state, is detrimental to its economy,” says Kelly. “Even if Texas wins its fight against Amazon and determines that it is permissible to tax Amazon whenever it has a physical presence in Texas, what does that accomplish? All it does is ensure that the price of goods for Texans rises.

“If Amazon simply stops doing business with Texans altogether due to the increased cost, then it won’t be an issue of higher prices through Amazon, but of completely removing the most competitive, price-lowering business in the world from the Texas market,” he adds.

Ideally, there shouldn’t even be a court case, Kelly says. The legislature should simply decide on its own that taxing out-of-state businesses doesn’t make sense.

But common business sense and government legislating don’t have a good record. Michigan enterprises know this well. In 2007, businesses went to bat against the state over a bill that charged an additional six percent on warehousing and logistics activities. The legislation was eventually repealed thanks to private sector input and outrage.

As the Michigan and Texas examples suggest, a major communication gap often separates the public and private sectors, especially in terms of planning. Then when trouble begins to stir, the parties are incapable of negotiating resolutions until after the fact.

With regards to the Amazon situation, many insiders remain incredulous that sales tax wrinkles weren’t ironed out from the beginning and that the Governor’s office and the state Comptroller weren’t communicating.

In the court of public opinion, Texas will bear the blame for Amazon’s decision. The company says it is defending online retailers from the onslaught of states desperate for new revenue streams. But when faced with legal action, it simply moves elsewhere. Whether other states will take a hard position, follow New York’s example and rewrite the books to account for e-commerce, or use sales tax exemptions as a business development incentive, remains to be seen. Online resellers, emboldened by Amazon’s gambit, may force the issue.

As the dust settles, it’s unlikely we’ve heard the last on this Texas showdown.

Red, White, Blue… and Green

The U.S. General Services Administration (GSA) launched the GreenGov Supply Chain Partnership and Small Business Pilot, a voluntary collaboration between the federal government and its suppliers to create a greener, more efficient supply chain.

The initiative aims to promote clean energy and cut waste and pollution by using greenhouse gas emissions as a measurement. Federal suppliers in the partnership agree to voluntarily measure and report their organization’s greenhouse gas emissions. Participating companies will share their experiences to help GSA develop a phased, incentive-based approach to developing contracting advantages for companies that track and disclose their greenhouse gas emissions.

The Small Business Pilot program will explore the benefits and challenges of measuring greenhouse gas emissions among smaller companies.

“The federal government is the largest energy consumer in the U.S. economy and purchases more than $500 billion in goods and services annually,” says White House Council on Environmental Quality Chair Nancy Sutley. “It is our responsibility to lead by example to improve efficiency, eliminate waste, and promote clean energy in our supply chain.”

On the Dock

Crossdocking is on the rise, according to Saddle Creek Corporation’s 2011 Crossdocking Trends Report. More companies are finding value in using the warehouse tactic to remove costs from the system, manage inventory levels, increase efficiencies, and accommodate unpredictable customer demand, according to the 3PL’s research.

During the past three years, crossdocking has increased significantly. More than two-thirds of survey respondents (68.5 percent) currently crossdock— up from 52 percent in 2008.

Companies identify crossdocking as a viable strategy for adapting to challenging market conditions. Of those who have been employing the tactic for four or more years, 40 percent report that challenging economic circumstances have prompted them to increase crossdocking either somewhat or substantially (see chart below, right).

The biggest benefits of crossdocking are improving service levels (38 percent), reducing transportation costs (32 percent) and consolidating shipments to destination (32 percent), according to the report. And more companies are recognizing the value of outsourcing this distribution function. A significantly larger percentage of crossdock practitioners (40 percent) use a 3PL either exclusively or in addition to in-house resources than in 2008, when just 32 percent of respondents who crossdocked reported using a third party.

Saddle Creek’s report is based on survey responses from more than 200 logistics decision-makers. Respondents represent a cross-section of logistics, with backgrounds in warehousing, distribution, and transportation.

Regulating Food Safety

Much has changed in the food supply chain since the government passed the Federal Food, Drug, and Cosmetic Act of 1938— its last major food safety legislation. The Food and Drug Administration’s (FDA) Food Safety Modernization Act (FSMA), which was passed in January 2011, was a long time coming.

During recent years, a rash of e. coli, salmonella, salmonellosis, botulism, and listeria contaminations have indicted familiar brands ranging from Taco Bell to Nestle Toll House. Isolating and controlling viral outbreaks, identifying rogue sources, and recalling tainted products are major challenges for the food supply chain and the FDA. Building a regulatory architecture that creates and communicates standards, then enforces compliance across the industry— measures aimed at immunizing the food supply chain from costly epidemics— is equally important.

The fact that this law takes a more preventive-control standard to make food safer, versus having the FDA react to outbreaks, is an important improvement.—Robert Guenther, United Fresh Produce Association

To gain perspective on how the new legislation will impact the food industry, Inbound Logistics caught up with Robert L. Guenther, senior vice president, public policy for United Fresh Produce Association, a leading trade association committed to driving the growth and success of produce companies.

IL: What aspects of the food safety legislation needed to be modernized?

Guenther: The FSMA was largely written to instruct the FDA on how to do a better job. The law needed to be updated to reflect modern food handling and growing practices. In particular, the fact that this law takes a more preventive-control standard to make food safer, versus having the FDA react to outbreaks, is an important improvement.

IL: One media account of the bill reports that some change is better than none. Do you agree?

Guenther: Yes. Consumer confidence about food safety was waning over the past several years, and something had to be done to address the situation. Of course, the devil is in the details. How the FDA implements and enforces this law will be the test of whether our policy makers made the right decision to reform food safety laws.

IL: How does the law affect shippers?

Guenther: Four major points concern shippers. First, the FSMA grants the FDA immediate, mandatory recall authority if a company refuses to voluntarily recall a product that may be adulterated, and consumption of the food will cause illness or death. But companies must get the opportunity to voluntarily recall first.

Also, effective immediately, during an active investigation of a foodborne illness outbreak, the FDA is authorized to direct that a farm identify immediate recipients of the food that is the subject of the investigation.

Second, federal regulations for the safe production of raw fruits and vegetables will be proposed within the next 12 months. The FSMA is relatively silent on the details of the regulations, but does require the produce standards to address growing, harvesting, sorting, packing, and storage operations, through the development of science-based minimum standards related to growing and packaging conditions.

Third, foreign growers will be held to the same federal food safety standards as domestic growers, and importers will be held responsible for providing proof.

And fourth, in addition to publishing regulations for fresh produce food safety, the FSMA requires FDA to issue a notice of proposed rulemaking, within two years, to establish additional recordkeeping requirements for product tracing of foods the FDA defines as ‘high-risk.’

IL: Is there a misperception that smaller producers lack the supply chain sophistication and quality control mechanisms used by larger corporations— and therefore ‘need’ increased regulation and inspection?

Guenther: The misconception is that small producers cannot afford food safety. But basic food safety practices should be a fundamental business decision for anyone selling to consumers.

IL: Smaller producers fear increased regulation will hurt their businesses; large corporations fear a lack of visibility and control among smaller growers will expose their liability when food recalls occur. Is there common ground?

Guenther: Yes. United Fresh has supported exemptions, provided there are science- and risk-based factors. We do not want the FDA issuing rules that apply the same for apricot producers as they would to leafy greens farmers. That makes no sense and is a waste of government resources. The federal government needs to focus on commodities that are more susceptible to micro-contamination and develop standards that help alleviate risk of outbreaks.

IL: Should the FDA have full recall authority over contaminated foods?

Guenther: The FDA has plenty of enforcement tools to adequately restrict the movement of food it deems harmful to consumers. Mandatory recall, which is now in the law, is another tool. But we expect it will not be used very aggressively, as the overwhelming majority of food operations in this country work with the FDA to avert a crisis during a recall situation.